"Free Insurance": Problems and Pitfalls in the Charitable Sector

By Stephan R. Leimberg

Life insurance is a powerful and positive charitable tool—but only if used properly in the right circumstances by a charitable organization that is prepared to screen, monitor and treat its insurance investments as it treats other investment assets. There are literally dozens of legal, creative and ethical ways that life insurance can benefit charities.

Recently, however, promoters have been approaching charities with a concept that enriches private investors more than the charitable organizations. It is called CHOLI, an acronym for Charitable-Owned Life Insurance and allusion to COLI, Company-Owned Life Insurance. Promoters claim that CHOLI is “a cash windfall for charity—without paying anything at all.”

CHOLI does not refer to the classic situation where a charity is given or purchases policies on the life or lives of key supporters with the intent to buy and hold. CHOLI denotes highly complex and speculative arrangements in which investors “borrow” the insurable interests of charities to enable them to do something the law does not allow them to do directly—to speculate on the lives of the organizations’ older, wealthy and generous donors.

CHOLI seeks to enable strangers to engage in what amounts to statistical gaming, gambling on the rate of deaths of a select group of elderly insureds. In most of these “dead pool” arrangements, there is a certainty that third-party groups of investors (primarily investment banks, insurance companies and hedge funds) will receive their shares of the “return on investment” sooner—in obscenely greater amounts—than the charitable organizations for which the arrangements are ostensibly (but not really) designed.

By sidestepping or, in some cases, actively instigating changes to weaken insurable interest laws that have, for very sound public policy reasons, survived for hundreds of years, investor groups hope to make what was intended to provide security into a security and convert human life into a mass commodity investment.

This commentary will help you decide when to advise the charity to reject certain life insurance proposals outright and when to recommend that the organization give the proposal full and serious consideration.

What Is Choli and How does It Work?
Although there are many variations on this theme, essentially, CHOLI works like this: An investment bank issues securities that investors purchase. The money from the sale goes into a trust (established by the participating charitable organization). The trustee uses trust funds to buy single-premium immediate annuities on the lives of wealthy, and typically older (ages 70 to 90), donors provided by the charity. The stream of annuity payments is used to buy life insurance on the same donors’ lives. Supposedly, the annuities will produce sufficient income to not only pay the life insurance premiums, but also provide a sufficient current fixed return to the investors on their investment, at least until the donor dies and the insurance proceeds are paid.

At the death of an annuitant/insured, the “life only” annuity payment ceases. The insurance proceeds are paid to the trust, and the investors recover their investment from the death proceeds received by the trust. If there is any death benefit remaining at that point, it is paid to the charitable organization.

Promoters estimate that the charity’s share of the death proceeds will be between 5 percent and 7 percent of the initial face amount. (No, that’s not a misprint. According to the marketing materials of the promoter, the charity—at most—gets between five and seven cents on the dollar!) It’s almost as if the promoter was paying the organization a commission to enable what—without the charity being involved—would in most states be illegal, as well as unconscionable.

Seldom do the promoters fully disclose to the charity or the insureds the names of the initial (or secondary market) investors, what is in it for them, or the full range of risks and potential costs to the charity and its insured patrons. Legal opinion letters rarely, if ever, offer comment on the probability of the charity’s economic success.

A Free Ride Offer for Charities
It is easy for a charitable organization to be seduced by possible profits from CHOLI-type schemes and “rent out” its charitable insurable interest and tax-exempt status to unscrupulous promoters and investors. And the charitable organization may ignore or never see how, or to what extent, third-party participants (investors) benefit from the “partnership.” The organization may appreciate only the risk it is taking by allowing its tax-exempt status to be used to enable that up-front private enrichment.

The Hidden Costs to the Charitable Organization
Charitable organizations that have been inflicted with legal and ethical but overly-optimistic charity-owned life insurance arrangements often find that premiums that were to have “vanished” not only never did, but that they climbed to such embarrassing levels that the charities’ relationships with the insured donors were strained or even threatened. In some cases, charitable organizations become victims of a scheme such as charitable split dollar (shut down by IRS Notice 99-36 and by Code Section 170(f)(1) that imposed penalties on such arrangements). These plans are similar to one that prompted Sens. Chuck Grassley and Max Baucus to state in Senate Bill 993, “These arrangements do more to facilitate investment by private investors in life insurance than to further the charity’s tax-exempt purposes” and that these are “snake-oil salesman taking advantage of tax-exempt organizations to line their own pockets with life insurance schemes.”

In addition, a charitable organization that participates in this arrangement may be faced with an unpleasant call from its state attorney general, concerned that it has “partnered” with private investors whose motive is other than a detached, disinterested generosity.

SOLI—CHOLI’s Cousin
A variation of CHOLI, called Stranger-Owned Life Insurance (SOLI), suggests that a charitable organization buy one or more financed policies on the lives of donors with the express intent of selling those policies to a life settlement company at the earliest possible date. SOLI has been condemned by the National Association of Insurance Commissioners (NAIC), the National Conference of Insurance Legislators (NCOIL), the Life Insurance Settlement Association (LISA), the American Council of Life Insurers (ACLI) and numerous states’ insurance departments, and it has resulted in many policy rescissions.

How Do You Analyze a Proposal?
Asking the following questions will significantly increase the probability of a positive outcome. As an advisor, you should refuse to go further on a proposal when you reach the limit of your comfort level. But remember that you do have a professional responsibility to the donors and to the charitable organization to objectively and professionally examine reasonable proposals.

Start with a background check: Ascertain the reputation of the person trying to sell the insurance. Demand a copy of the seller’s educational, experiential and professional background. Check with charities that have actually implemented this arrangement—with this marketer—to find out their experiences, successes, problems and concerns. Ask for a written report on how many of these plans the seller has put in place.

Require clear and full explanations: Demand a step-by-step outline of the process and make a list of the questions you have. Be particularly concerned if the plan’s success is based on a multiplicity of assumptions (are they reasonable?) or “multiple moving parts,” the failure of any one of which could thwart the objectives.

Confirm that you are dealing only—and directly—with reputable, top-rated insurers: Insist on seeing information based only on the direct backing of a major and well-known highest rated insurer. Require a letter from the general counsel of that company assuring the charity that the tax and other representations provided to you are correct.

List key assumptions: Make a list of assumptions or variables that, if they do not work as projected, could significantly affect the proposal’s outcome.

Draw up a list of the disadvantages and exposures the charity and its donor(s) may face under the proposal. Demand that the seller provide a best/worst/probable case range of rewards and costs. What is the maximum downside (or upside) if interest rates, mortality assumptions and the cost of insurance increase—or decrease—significantly beyond anticipated limits?

Require a written backup plan and/or detailed exit strategy: Insist on an estimate as to any charges, penalties or other costs that will be incurred. Separate guarantees and specific promises from projections. To the extent death benefits are not guaranteed, or if there is a change in interest rates, policy performance or mortality costs, there is a significant risk that a premium-financed life insurance program will not only disappoint and fail to meet anticipated goals, but also put the charity’s other assets in jeopardy.

Ascertain and reassess the charitable organization’s risk-taking propensity: Leverage is a double-edged sword. Borrowing has the potential for great rewards—but equally great losses. Decide in advance how great the charity’s tolerance is and what will happen if implementation of the proposal entails risks beyond acceptable levels for the charity. Go slow on debt!

Determine legal and tax exposures: Do not sign a nondisclosure agreement. Such agreements are almost always an indication that the promoter doesn’t want you or the charity to share information with other knowledgeable advisors.

Investigate to see if the proposal entails securities/UBTI/private benefit/private inurement type issues: If the organization is to remain exempt, any private benefit arising from a particular activity must be “incidental” in a qualitative and quantitative sense to the overall public benefit achieved by the activity.

Check state law regarding insurable interest: Ensure that the charity has the requisite insurable interest, a major legal concern.

Discuss the psychology involved: Does a donor have to die for the organization to profit? How will its supporters react when they know the organization has a vested interest in their premature deaths (i.e., the organization is betting against donors’ longevity). Would the supporters’ answers change when it is discovered that strangers will end up having a financial stake in their life expectancies and that the organization will probably lose money or never collect what is expected if they live too long? How will supporters feel when they find that the investors will have the right to obtain confidential financial and health information on plan participants—in some cases monthly—for the rest of their lives? Would the supporters object if they knew that the policies on their lives may be sold by the present investors to other (perhaps less reputable) investors in a manner similar to the turnover in mortgages?

Gauge your loan obligations: Demand—at the outset—a complete set of the debt instruments, contracts or other legal instruments that the organization will be required to sign. Be particularly sensitive to any collateral beyond the policy that the organization will have to pledge, or other guarantees it will have to make. Consider if the organization will have to borrow money to finance insurance premiums and how that debt arrangement will affect the charity’s credit status.

Run the numbers: No one has proved that CHOLI will really benefit a charity—or to what extent. What are the up-front fees? What are the likely annual administration, legal and accounting costs? What does the charity’s independent counsel/actuary study show? (It is essential to spend the money to have the economics and tax claims of the proposed arrangement independently checked and verified.)

Who are the initial third-party investors? Who will those investors sell their interests to if another more profitable use of the investment comes along, or if they believe this investment is no longer profitable?

The Bottom Line
Objectivity, enhanced knowledge, uncommon common sense, open-mindedness, and more than a dash of personal integrity and courage will help you identify and distinguish between proposals that are pure alchemy and those that are true gold and make the right decisions on how to maintain the balance. Life insurance that is bought and held can help a charitable organization fulfill its charitable goals to a degree that might otherwise not be possible—but only if it is used wisely.

Please call The Office of Gift Planning at 507-457-6647, or e-mail us at giving@smumn.edu, for more information.

Author Bio
Stephan R. Leimberg, J.D., is CEO of Leimberg Information Services Inc., an e-mail and database service providing information and commentary on tax cases, rulings and legislation for financial services professionals. He is also CEO of Leimberg and LeClair Inc., an estate and financial planning software company. He is co-author of Tax Planning With Life Insurance and has addressed the Heckerling Tax Institute, the Notre Dame Law School Tax and Estate Planning Institute, ALI-ABA’s Sophisticated Estate Planning Techniques course, ALI-ABA’s Planning for Large Estates course, the NYU Tax Institute, the National Association of Estate Planners and Councils’ national conference, the AICPA’s National Estate Planning Forum, and Duke University Law School’s Estate Planning Conference. His e-mail newsletter/database www.leimbergservices.com is used daily by thousands of estate, financial, employee-benefit and retirement planning practitioners.

Always a Day Away

By Russell A. Willis III, J.D., LL.M.

The charitable remainder trust, and its many variations, remains a valuable tool for the charitably minded. Often the settlor of a charitable remainder trust, however, will want to provide an annuity or unitrust benefit for someone other than him- or herself—a spouse, child, sibling or parent. Complications may arise if the annuity or unitrust interest is not immediate, if it otherwise does not qualify for a marital deduction, or if the present value of the income stream exceeds the gift tax annual exclusion.

The following vignette explores the gift and estate tax issues that can arise in connection with designing a charitable remainder trust from which someone other than the settlor is to receive an annuity or unitrust payout.

Industrialist and philanthropist Oliver W. has asked you to assist him in designing a trust that will provide a reliable stream of income for his adopted daughter, Annie B., for 20 years, with the remainder to benefit his alma mater, the School of Hard Knocks, a 501(c)(3) organization. While discussing this idea with you, Oliver also mentions that he is considering marrying his longtime personal assistant, Grace F., and suggests that he may want to set up a similar plan for her—possibly for her life, rather than for a term of years. Oliver is 62 years old, Annie is 18 and Grace is 34.

You begin by acquainting Oliver with the basic principles of charitable remainder trusts: the fixed annuity or a variable unitrust payout; 5 percent or more; net income with or without makeup; the income tax deduction for the charitable remainder; present value at least 10 percent; and so on.

A Plan to Provide for Annie
The next step is putting some numbers together for Annie's circumstances. You suggest a 20-year trust¹ funded with $100,000 of marketable securities, paying $5,000 per year to Annie for the lesser of her life or 20 years, and generating a charitable contributions deduction of a little more than $29,000.

"However," you caution, "by the same math, the present value of the annuity to Annie is almost $71,000. And although the gift to her of an ‘income' interest is a present interest gift, eligible for the $12,000 annual exclusion,² everything above that amount would be a taxable gift, reducing your $1 million lifetime exemption."

Oliver asks, "Is there a way around that?"

"Yes," you say. "You could reserve a power to revoke the annuity, which you could exercise only in your will.³ The result would be that the annuity would be a completed gift to Annie only as it is actually paid out."

"Exercise only in my will. I know you want to tell me the logic of that rule."

"Yes, it has to do with whether the trust is a ‘grantor' trust for income tax purposes."

"Nevermind that," Oliver says. "What about setting up something similar for Grace?"

Grace's Plan
Oliver presents a general idea of what he wants to accomplish: "I want something that will provide for her lifetime, with some protection against inflation. And would it make a difference if I married her?"

"It could," you say, "if we set up the trust in such a way as to qualify for a gift tax marital deduction. Ordinarily, if a trust that pays out something other than the entire net income to a spouse—here, a unitrust amount—and the remainder goes to a third party, it would not qualify for the marital deduction. There is, however, a specific exception in the tax code for charitable remainder trusts.⁴

"Again, to put some numbers to it, the present value of the charitable remainder after a 5 percent unitrust for Grace's life would be more than $15,000,⁵ and the present value of the payout to her would be nearly $85,000, but you would not need to worry about the annual exclusion or the lifetime credit because of the marital deduction."

Oliver appears to be calculating something. "The idea being," he says finally, "that the tax people expect her to live a certain number of years."

"Forty-three and a half," you confirm.

"But if she doesn't, Hard Knocks gets its money early, and I don't get any further tax benefit. What would happen if we made the unitrust payable to me after Grace's death?"

"That's an interesting idea," you admit. "The arrangement actually would qualify for the gift tax marital deduction under the exception I just mentioned." A smile of self-satisfaction flickers across Oliver's face.

"Of course," you continue, "the present value of the remainder, the income tax deduction, would be slightly less, more like $13,555.⁶ The actuarial likelihood that you will outlive Grace is not very high. Though if you did survive her, you could accelerate the remainder to Hard Knocks and take an income tax deduction for the then-present value of your unexpired unitrust interest."

The QTIP Alternative
"Another approach," you offer, "would be simply to make this a type of income trust, called a QTIP (qualified terminable interest property) trust, with no charitable deduction at all for now. You could authorize the trustee to distribute principal to Grace if she needed it. Assuming Grace survived you, the contingent income interest to you would simply lapse, or if you survived, the remainder to Hard Knocks at your death would be deductible in your estate. Or…"

Oliver holds up his hand. "One thing at a time. Why wouldn't there be a charitable deduction now?"

"It is because this would not be in the form of an annuity or unitrust." And you give him a brief history of the 1969 legislation that closed down the former abusive practice of setting up a trust that paid income to an individual beneficiary with a remainder to charity, claiming a deduction for the present value of the remainder, but then investing the trust entirely in high yield, zero growth assets.

Oliver nods. "All right," he says. "The QTIP will pay income to Grace for her life and offer discretionary distributions of principal, but I receive no charitable deduction at the front end. Plus the QTIP pays a contingent income interest to me if I survive her. Suppose she dies before I do, but I have no need for the income. Can I claim a deduction for accelerating the remainder to Hard Knocks?"

"I can see an argument for that position," you say cautiously, "but there might be a question under what is called the 'partial interest rule.'⁷ Certainly you could disclaim the income interest, which would have the effect of trading a marital deduction for a charitable deduction in Grace's estate, assuming her estate was taxable. Or you could simply turn the income over to Hard Knocks as it came in, which could work out to be a wash and would spread the deductions out over your lifetime, rather than taking the deduction in one year with a five-year carryforward."

Oliver seems momentarily distracted. "If Grace's estate were taxable," he muses, "that would be, what, something over $2 million?"

"This year, yes," you say. "It increases to $3.5 million in 2009 and is unpredictable after that."

Circumstances That Require Further Consideration
Thinking ahead, you begin, "You know, Oliver,…"

"Yes," he says. "We might not still be married when this all comes down."

You continue, "If we set this up as a QTIP, we could make any provision for discretionary distributions of principal conditional on her remaining married to you. Contrarily, if we set this up as a net income unitrust with makeup, we could have it flip to a straight unitrust in the event of your divorce, trapping any accrued deficits in the trust."

"But could we provide that in the event of divorce the unitrust payout goes instead to Annie?" Oliver asks.

"That would disqualify the trust for the gift tax marital deduction,"⁸ you note. "Also, the present value of the remainder after two lives, with Annie being as young as she is, would be nowhere near the required 10 percent. What we could do, though, is limit the trust to a term of 20 years and have you reserve a testamentary power to revoke the unitrust payout to either beneficiary, so that, again, the gift would be complete only as the distributions were actually paid out to either Grace or Annie."

"Let's stay with the idea of creating an income stream for Grace for her lifetime," Oliver says. "Presumably my lawyers will put together some elaborate prenuptial agreement, providing some reasonably substantial benefit to Grace in exchange for her waiving claims to something even more substantial. Could this trust, whether it is a charitable remainder trust or a QTIP, be set up as a part of that agreement?"

"It could," you say, "provided the transfer is made after the marriage is formalized. You cannot claim a gift tax marital deduction for a transfer to someone who is not yet your spouse. The U.S. Treasury has adopted a regulation⁹ saying that a transfer in exchange for a waiver of marital rights at the outset of a marriage is not ‘consideration' in money's worth. Whereas if you entered a similar arrangement after you were married, such as a divorce settlement within two years before or one year after the decree, it would be a taxable exchange."¹⁰

Oliver glances at his watch and leaps to his feet. "Anything else I need to know?"

Review Objectives and Outcomes
"We have talked about having you reserve a testamentary power to revoke someone's annuity or unitrust interest in order to make the gift incomplete for tax purposes," you remind him. "In those scenarios, if you died holding that power, or within three years of relinquishing the power,¹¹ the unexpired annuity or unitrust interest would be included in your gross estate for estate tax purposes, even though it would be payable to Grace or to Annie.¹² If it did not qualify for the marital deduction, it would generate an estate tax. You would need to make a provision in the trust document or in your will for paying the incremental tax from assets other than the charitable trust itself.¹³ You might even require that the recipient pay the tax as a condition of receiving the annuity or unitrust payout."¹⁴

Oliver growls. "Anything else?"

"Is Grace an American citizen?" you ask.

Oliver drops back into his chair. "Why do you ask?"

You reply, "It would make a difference in how we would have to structure anything we wanted to qualify for the marital deduction for gift or estate tax purposes. A gift in trust for a non-citizen spouse that would qualify for the marital deduction only if a QTIP election were made would not be eligible for the same unlimited marital deduction as a similar gift to a citizen.¹⁵ Instead, you would be limited to $12,000 per year. The trust instrument could include provisions that permit the trustee, at your death, to hold back from any distribution of principal an amount equivalent to what would have been the incremental tax in your estate had a marital deduction not been allowed.¹⁶ The idea with this strategy, Oliver, is to protect against the noncitizen spouse expatriating assets that would otherwise be taxable at her death.

"In any event," you conclude, "it can be done with a charitable remainder trust because no QTIP election is required. The IRS has approved the arrangement privately.¹⁷ But the marital deduction would be limited to $120,000."

Oliver stands again and strides to the door. "Put something on paper," he says.

Please call The Office of Gift Planning at 507-457-6647, or e-mail us at giving@smumn.edu, for more information.

¹ Based on fixed annual payments and a 3.4 percent charitable midterm federal rate.
² Code Section 2503(b).
³ Reg. 1.664-2(a)(4) and -3(a)(4).
⁴ Code Section 2523(g)(1). There is a similar exception at Code Section 2056(b)(8) for estate tax purposes.
⁵ See note 1.
⁶ See note 1.
⁷ Code Section 170(f)(3).
⁸ Code Section 2056(b)(1).
⁹ Reg. 25.2512-8.
¹⁰ Code Section 2516.
¹¹ Code Section 2035(a)(1).
¹² Code Section 2038(a)(1).
¹³ 13Rev. Rul. 82-128, 1982-2 C.B. 71.
¹⁴ 14PLR 9512016.
¹⁵ Reg. 25.2523(i)-1(d), example 4.
¹⁶ Code Section 2056A(a)(2).
¹⁷ 17PLR 9244013

Choosing the Right Charitable Remainder Trust

When someone is interested in supporting Saint Mary's University by a deferred gift plan, the simplest methods are a bequest, or life insurance or pension plan beneficiary clauses. The alternative of an irrevocable charitable remainder trust (CRT), however, can meet as many as three personal objectives in addition to reducing death taxes and carrying out the charitable intent. Those objectives include:

• improved income for yourself and/or for others.
• current income tax savings from a charitable deduction.
• avoidance of capital gains taxes if funded with appreciated assets otherwise to be sold.

• Standard Charitable Remainder Unitrust (referred to as Type I, or STAN-CRUT)
• Net Income Only, Plus Make-up Unitrust (referred to as Type II, or NIM-CRUT)
• Net Income Only Unitrust (referred to as Type III, or NI-CRUT)

Click the icon to request your FREE guide to charitable remainder trusts. We'll e-mail it to you within minutes!

Gift Planning Basics: Matching Methods to Motives

Clients have a variety of reasons for considering a significant charitable gift. Fortunately our tax structure and its incentives for philanthropy have developed an equally varied array of giving methods. Following is an overview of some of the most common and popular gift vehicles.

Most gifts fall into one of three groups:

• a single outright lifetime transfer or series of annual gifts;
• revocable arrangements for a future gift;
• irrevocable provisions for a deferred gift.

• Death benefits for a charitable organization reduce a taxable estate and pass contractually outside of probate, in confidence, and are less subject to contest by a disgruntled heir than a bequest through a will.
• The gift involves no administrative expense or settlement costs.

The simplest way to use life insurance is to name a qualified charitable organization as the beneficiary (not policy owner) of a new or existing policy. The insured policy owner retains the power to change the beneficiary designation, making it a revocable plan with no completed gift and no current income tax deduction. If the organization is made policy owner, annual unrestricted cash gifts to cover premium costs are tax-deductible.

Qualified pension plan assets. Many people remain unaware of how income tax liability erodes the value of their retirement plans. Funded with pretax income, and appreciated without being taxed, their total value remains subject to income tax if taken by the participant, transferred to heirs or left in the estate to be taxed as income in respect of a decedent (IRD). With an estate subject to estate tax, what is left is then taxed again, consuming as much as 65 percent of the account, notwithstanding state income and death taxes.

These assets can be the most costly gift to heirs. Conversely, they make an efficient revocable charitable gift, easily arranged by a plan's beneficiary designation and not taxable as IRD to the charitable organization. In order to arrange this type of gift, simply obtain a change of beneficiary form from the retirement plan provider. If the donor is married, the spouse will need to sign a waiver to name someone other than the spouse as beneficiary of a retirement plan. This waiver, however, is not required if the asset is an IRA.

Irrevocable Provisions for Future Gifts
Split-interest charitable remainder trusts. These types of arrangements provide the greatest tax advantages, including an immediate tax deduction, avoidance of up-front capital gains tax, increased lifetime income and reduced estate taxation.

There are two broad types of remainder trusts. Those with fixed dollar payments to income recipients are charitable remainder annuity trusts or CRATs, typically preferred by older grantors. Those with a variable income stream, depending on growth or decline in the value of the trust's assets, are charitable remainder unitrusts or CRUTs. Grantors with a longer life expectancy and concerns about inflation are likely to prefer a unitrust with its potential for growth in income when investments include equities. In addition, there are four variations of unitrusts to offer donors still more flexibility: a standard unitrust, net income with makeup provisions unitrust (NIMCRUT), net income with no makeup provisions unitrust (NICRUT) and a flip unitrust.

For example, a 75-year-old donor uses $100,000 in securities to establish a standard charitable remainder unitrust paying 6 percent per year. The donor's charitable income tax deduction is $55,490. In the first year, he will receive $6,000. Each year after that, the payment will be determined by the value of the assets in the trust and hence the amount of the payment will vary each year. The payments are taxable to him under the four-tiered system for charitable remainder trusts.

Charitable gift annuity contracts (CGAs). CGAs are the oldest form of income-producing charitable gifts, dating back to the mid-1800s, but are not available in all states or offered by all organizations. Charitable organizations that enter into such contracts are the issuer and payor of income for one or two annuitants.

Some donors will prefer a gift annuity contract to a charitable remainder annuity trust, for any of several reasons. For older annuitants, the annuity rate can be higher than what would be available from a CRAT. Payments received are partially nontaxable for a number of years, considered as return of investment in the contract.

The transaction is in part a charitable gift and in part the purchase of the income interest. When a donor transfers marketable, long-term capital gain property instead of cash in return for the annuity interest, the amount of appreciation in the property is prorated between the gift portion and the purchase portion. There are two advantages related to capital gain. One, the amount allocated to the gift portion completely avoids capital gains tax. Two, the portion to be recognized can be spread over the projected term of the contract when the donor is the income beneficiary, and any tax deferred is money saved. Note, however, that the last advantage is offset to some degree because the prorated lower-taxed capital gain portion of annuity payments squeezes out an equal amount of untaxed return of investment.

Other benefits of a CGA:

• The arrangement requires a simple contract, with no need for a trust agreement.
• The obligation to pay the annuity is a claim on all assets of the issuer.
• Start of payments can be deferred, which increases the initial itemized deduction and the annuity rate.

• $1,171 income tax–free
• $3,512 taxed as long-term capital gain
• $2,017 taxed as ordinary income
• $6,700 total payment

Lessons From the Experts

Charitable planning can be one of the most satisfying areas in which an advisor can practice. When your clients' interests and charitable organizations' interests are in line, the results can be terrific. Charitable planning is a specialty, however, with technical rules and an abundance of potential pitfalls. The purpose of this article is to alert you to some of the pitfalls you may encounter, enabling you to do a better job for your clients. In our experience helping many clients fulfill their philanthropic objectives and in sharing experiences with other advisors, we have come across some common traps for the unwary.

Disengage Yourself From the Outcome
As human beings, advisors can sometimes lose sight of their biases. If you hold yourself out as a charitable planner, sit on charitable boards or have seen the positive results of charitable planning in other clients' situations, it pays to remember to approach each client with a fresh perspective and to stay objective. As advisors, your first duty is to your clients. This responsibility as advisors means helping them uncover their goals and priorities, including any charitable goals. The most successful approaches endeavor to educate clients about the costs, benefits, risks and rewards of charitable planning. Detailed explanations of the various planning vehicles, illustrations and schedules can all aid in conveying this information. It is important to discuss with your clients and agree upon assumptions, including rates of return, inflation and life expectancy. Using software that can predict the probability of what the client considers a successful outcome is helpful. The client can then make an informed decision.

Consult Other Experts
Charitable planning and implementation often cross many disciplines, including law, accounting, investments, insurance and strategic philanthropy. It is unlikely that there is even one advisor who possesses genuine expertise in all of these areas, so for those who don't have all these skills, there are teams. Teams can be formal business relationships or informal alliances. Taking a team approach to charitable planning could avert many of the errors discussed below.

Errors in Drafting
Trust companies, investment firms, charitable organizations, even the IRS, distribute form documents for charitable vehicles. While this may add value for a client or prospective donor, it is important that the client retain an attorney experienced in charitable planning to draft the document, rather than relying on a form to save expenses. Look out for these provisions in charitable remainder trust (CRT) forms:

• Trustee Provisions
  While many form-CRT documents do not name the client to serve as trustee, generally there is nothing prohibiting the client from serving as trustee of a CRT. In fact, most clients want to maintain control. Thus, clients should be informed of this opportunity in evaluating trustee options.
  
• Charitable Remainder Beneficiary
  Many forms do not permit the client to name more than one charitable remainder beneficiary or to change the charitable beneficiary during the client's life. The client's advisors should present these options.
  
  In addition, it is important for the client to decide whether he or she wants the flexibility to ever name a private foundation as the remainder beneficiary. This decision may affect the client's ability to take the income tax deduction generated by the gift to the CRT. As a general rule, clients may take deductions for gifts of appreciated property to public charitable organizations up to 30 percent of the client's adjusted gross income (AGI) in the year the gift is made. If the gift exceeds 30 percent of the client's AGI, the client may carry the deduction forward over five years. With gifts of marketable, appreciated securities to a private foundation, a client may deduct gifts up to 20 percent of AGI per year over six years. In the context of a CRT, if the trust prohibits a private foundation from ever being named remainder beneficiary, then contributions to the CRT will be subject to the higher 30 percent limitation.
  
  When a client is establishing a charitable remainder trust, the client's accountant should prepare income tax projections to determine whether and how quickly the client will use the income tax deduction. If the entire deduction at the private foundation percentage limitations can be easily used, there is no reason to restrict the remainder beneficiary to a public charitable organization. While many clients will never establish a private foundation, flexibility should be favored in irrevocable instruments unless there is a countervailing reason. On the other hand, if the client's ability to use the deduction may be compromised by the 20 percent limitation, it may be better to prohibit private foundations. If property other than marketable securities is to be contributed, the remainder beneficiary should be a public organization; otherwise the deduction will be limited to cost basis.
  
• Early Distributions of Trust Principal
  If a client wants to make a large current gift, but is concerned about cash flow, accelerating the charitable remainder can be a good strategy. Many form documents do not permit early distributions to the remainder beneficiaries, so it must be custom-drafted. If a properly drafted provision is included, the client can accelerate all or a portion of the charitable remainder interest during the client's life.
  
  Consider the following example: Joe sets up a 6 percent standard charitable remainder unitrust, to which he contributes $1 million. This trust would pay Joe $60,000 in year one. Assuming the trust principal also earns $60,000 in year one, the trust would pay him the same $60,000 in year two. If Joe decides in year two that he would like to make a $20,000 outright charitable gift, he could satisfy the gift with $20,000 of his other assets. But if Joe doesn't want to part with $20,000 of his other assets, he could accelerate a $20,000 portion of the remainder interest in his CRT. If he did so, the trust principal at the end of year two would be $980,000 and Joe's year-three payment would be $58,800. In this case, Joe is only out of pocket $1,200 in year two. In addition, as a result of his gift in year two, Joe would receive an income tax deduction equal to the present value of his income interest in the $20,000. The decreased principal will also diminish his payments in future years.
  
  If the opportunity to make a charitable gift in this manner arises, take care that the transaction is conducted in such a manner as to avoid self-dealing, as discussed below.

Investing and Administrative Errors
In addition to skilled drafting, careful investment and administration of charitable trusts are essential. Charitable trusts, like all split-interest trusts, require a sound investment policy that balances the interests of the life and remainder interests. The Prudent Investor Rule charges the trustee to consider each investment in the context of the whole portfolio and does not eliminate per se any particular investment. In addition, complex tax rules apply to charitable trust investments and cannot be overlooked. Here are some of the most common issues we have come across in our practices:

• An Ad Hoc Investment Approach
  In many instances, a client may serve as trustee of a charitable trust. While this may be technically possible and even desirable in many cases, it is important that the client be cognizant of the fiduciary duties of trustee. As trustee, the client cannot favor the life beneficiary over the remainder beneficiary, and vice versa. In the case of a split-interest charitable remainder trust, the state attorney general may intervene on behalf of the charitable beneficiary to prevent the beneficiary's interests from being compromised.
  
  Thus, while a client may want and be able to serve as trustee of his or her charitable trust, it is generally advisable for the client to hire investment advisors experienced in investing charitable trusts. Such an investment advisor will typically develop an asset allocation and investment policy statement for the trust that addresses these issues and prohibits improper investments. It is equally important for the investment advisor to consult with the other members of the client's advisory team.
  
• Lack of Diversification
  Most states impose a duty to diversify on trustees. Where the client is serving as trustee, he or she may have a difficult time diversifying. Where the charitable entity is funded with stock from the client's business or with real estate that the client has owned for a long time, diversification may be particularly difficult. The difficulty can stem from internal causes (e.g., emotional attachment) or external causes (e.g., stock trading restrictions or market conditions). In these cases, it is even more important that the client work with advisors experienced in such areas to develop a disciplined diversification plan as part of the investment policy and asset allocation.
  
• Unrelated Business Taxable Income (UBTI)
  An example of an improper investment is one that generates unrelated business taxable income (UBTI). UBTI is most commonly created by debt-financed income. The most common examples of UBTI are assets purchased on margin; publicly traded limited partnerships, which pass through debt-financed income; rental real property acquired with debt; and alternative investments, such as hedge funds.
  
  The consequences of generating UBTI can be severe. If a CRT or supporting organization recognizes even one dollar of UBTI, it would be taxable on all its income for that year. If the year happens to be the year in which the entity sells a large block of appreciated property (such as the low basis property it originally received), the effect can be very bad indeed. UBTI in a charitable lead trust (CLT) can severely limit the trust's ability to deduct the income interest paid to a charitable organization.
  
• Self-Dealing
  An excise tax is imposed on each act of "self-dealing" in which a charitable trust or foundation engages. Self-dealing is typically a transaction between the charitable entity and a "disqualified person." The term "disqualified person" includes a substantial contributor to the entity; a foundation manager, including an officer, director or trustee of the entity; and family members of a contributor or foundation manager. An excise tax of 5 percent is charged to the disqualified person and an additional 2.5 percent excise tax is levied on the foundation manager who knowingly participates in an act of self-dealing.
  
  The most common forms of self-dealing are transactions between the client and the charitable entity that he or she established, such as sales, loans, payment of unreasonable compensation and use of trust property for the client's benefit. One less obvious potential act of self-dealing is the satisfaction of a charitable pledge. Even if a pledge is not legally binding, there is the possibility that the satisfaction of such a pledge with charitable trust or foundation assets could be construed as self-dealing.

How Investment Decisions Affect Life Income Gifts

By Eric Swerdlin

Anyone involved in the creation or planning of life income gifts knows that 2000 - 2003 were the most challenging years since the Tax Reform Act of 1969 (TEFRA '69) codified the rules regarding these gifts. During that time the coupling of a significant equity market pullback and the lowest fixed interest rates in 45 years created challenges for the maintenance of donor relations and establishment of new gift plans, and created discomfort for fiduciaries managing ongoing gifts. Also, the decoupling of investment returns (bond prices move in an inverse way to yields) highlighted and validated the Prudent Investor Act's mandate to diversify portfolios. Furthermore, these events highlighted the need for full disclosure when gift planners meet with donors to discuss gift arrangements.

During the fourth quarter of 1969, when TEFRA '69 was signed into law, the average constant maturity 10-year Treasury note yielded up to 7.51 percent. With a 7.5 percent interest rate environment as a backdrop during these three years, the mandatory 5 percent annual payout from charitable remainder trusts seemed wholly reasonable.

As of the writing of this article (2003), the 10-year Treasury note hovered around 4 percent. Also, widespread usage of personal computers did not become commonplace until the mid-1980s, by which time interest rates had peaked in the mid teens: Advisors could now, using the first versions of software designed to illustrate the economic result of creating a charitable remainder trust, forecast ending remainder values and annual payout amounts from charitable remainder trusts.

New Software. These software programs typically asked the advisor to plug in assumed rates of return, both growth and income, and then performed a linear extrapolation. Unfortunately, if the assumed return was higher than the payout rate for a unitrust, the graphs would show ever increasing levels of payout and remainder values. Having a bull market for most of the late ’80s and all of the 1990s led many advisers to feel comfortable with these illustrations.

More recently a new model has emerged—one that uses the probability theory to illustrate the potential likelihood of attaining certain results for both the income beneficiary and the remainderman. This new software-modeling tool does a much better job of preparing the donor for potential economic results.

Full Disclosure. Another change in gift presentation has been a move to increased disclosure about the attributes of the various gift vehicles. When discussing potential gift arrangements, time must be spent discussing the best case and worst case scenarios of a gift plan. A good starting point is to discuss variable payout versus fixed payment life income gift vehicles. It has long been axiomatic that trusts created by relatively young donors should be unitrusts, with a varying payout, and trusts expected to be of a relatively shorter duration should be annuity trusts, paying a fixed payout.

But is this necessarily so? In reality, much more emphasis must be paid to the donor's risk tolerance, with a particular focus on the donor’s ability to weather downturns in annual cash flow in the context of their overall financial planning.

Just as in any diversified portfolio, there are investments that are fixed payments (fixed income) and those with variable returns (equities), and there is no reason that a life income gift cannot be part of an individual's fixed-income portfolio. A fundamental difference between a charitable remainder annuity trust and a charitable remainder unitrust is that in an annuity trust investment risk is almost entirely borne by the remainderman. The notable exception to this is the risk to the income beneficiary of exhausting the entire principal and having the payments cease. With a unitrust, the investment risk is borne more evenly by both income beneficiary and the charitable remainderman.

The need for full disclosure about the variability of payout can be seen clearly through the historical performance of pooled income funds. In the early 1980s, with interest rates in double digits, pooled income funds became an extremely popular life income gift vehicle. After all, donors were told they could receive double-digit returns and still get a tax deduction.

Finally, a critical component in providing stewardship and protecting oneself is to maintain a file that documents the amount of disclosure furnished to the donor. A file showing the efforts made by the gift planner to inform the donor of the best case/worst case scenarios and the different attributes of the gift vehicles can go a long way with forgetful donors and litigious relatives.

Charitable Remainder Trusts
Fiduciaries of split-interest gifts must manage these assets with an eye toward tax awareness, including the fact that the annual income distribution of all charitable remainder trusts is taxed under a four-tier tax system.

A Four-Tier Tax System

• Tier 1: Ordinary income (taxable bond interest and stock dividends)
• Tier 2: Capital gains (distributed short-term gains first and then long-term gains)
• Tier 3: Other income (e.g. tax-free)
• Tier 4: Return of principal

The Charitable Lead Trust: A Phenomenal Estate Planning Tool

By Doug White

Of all the charitable planning tools, the charitable lead trust (CLT) is one of the more beneficial types of gifts. But, because of its complexity, it is also one of the least utilized planned gifts.

Donors can make a gift that will immediately generate income to one or more charitable organizations at relatively little cost to the family because of estate and gift tax savings.

At the end of the trust's term, its remaining assets are distributed to family members. Although the trust document must specify the payout amount, the donor does not have outright control over income distributions, but can only make suggestions about which organizations will receive the trust payments each year.

A lead trust established during lifetime can be set up as either a grantor or nongrantor trust for income tax purposes. Most lead trusts are of the nongrantor type.

If estate planning goals are not paramount, a grantor lead trust may be established, and thus the grantor would be subject to income taxes because of the retained reversion.

In other cases, the trust may be a grantor trust because of retained powers that cause the grantor to be taxed for income tax purposes but do not cause the assets to be pulled back into the grantor's estate for estate tax purposes.

The grantor lead trust is useful for someone who has unusually high income in the current year and wishes to accelerate charitable deductions for future charitable gifts into the current year.

Tax Consequences
A charitable lead trust is not exempt from income taxes. Whatever income is not paid to a charitable organization and any realized capital gains in a given year (other than gains realized on satisfaction of the payment obligation with appreciated property) are taxed at trust rates. The remainder value, the amount a donor is permitted to deduct when setting up a remainder trust, is, in a lead trust, the amount considered a taxable gift to the remainder beneficiaries when the lead trust is established.

While, at the outset, a tax may be due on a fraction of the trust's value if the donor has exhausted his or her applicable credit, by the end of its term whatever value the trust has grown to is not taxed.

When the assets are transferred to a noncharitable remainderman, usually children or grandchildren, the transfer takes place tax free (although the generation-skipping tax may apply when a grandchild is a remainder beneficiary). This is because a snapshot of the asset's value is taken at the time the trust is established and the value of the remainder, determined by an IRS calculation, is considered a gift for gift tax purposes.

What This Means
Assume that a person establishes a charitable lead annuity trust for a 20-year term with $1 million worth of stock, and that the trust pays an annuity to one or more charitable organizations totaling 5 percent per year. The equation to calculate the trust's income and remainder values depends on several factors: what goes into the trust, how much is paid out, how frequently payments are made and for how long. Plus, there is an additional important element: the IRS discount rate, which changes monthly. A few years ago this number dropped to historic lows, meaning the remainder of a trust established then was valued quite low. In July 2003, for example, the number was 3 percent, lower than it had ever been in the past or has been since.

Reminder: In the case of a charitable lead trust, as with other transfers involving a charitable gift, the donor can value interests using the IRS discount rate for the month of the transfer or for either of the two months preceding the month of transfer.

For this example, let's use a rate of 3.2 percent from mid-summer 2003. It will give us a general idea of how it affects lead trust planning. The annuity value for the $1 million trust equals $730,000, and the remainder value equals $270,000. This means that of the $1 million, $730,000 is subtracted from the amount that is subject to tax.

For illustration purposes, without regard for state estate taxes, assume the donor is in a 40 percent transfer tax bracket, and assume the lifetime credit is completely used up. He or she pays $108,000 in gift taxes.

Contrast that to an IRS discount rate of 6% from June 2006. The remainder value, all other factors being the same, is $426,500; income value is $573,500.

By using a 40 percent transfer tax assumption, the tax would be $170,600. That is a tax increase of $62,600 for a trust with a 6 percent discount rate, even though nothing has changed other than the discount rate. The two examples cited are for a charitable lead annuity trust.

A lead trust can also be a unitrust, which pays a fluctuating percent each year based on the value of the trust's assets. The calculation to determine the remainder and income values for a unitrust is fundamentally different from that used to determine the same values for the annuity trust, and the results differ markedly. The discount rate has more of an impact on the annuity trust.

Remainder and income values for charitable lead remainder trusts with terms of 20 years and payouts of 5 percent, but with different IRS discount rates. The tax is calculated using a 40 percent transfer tax bracket.

Remainder and income values for charitable lead remainder trusts with terms of 20 years and payouts of 5%, but with different IRS discount rates. The tax is calculated using a 49% transfer tax bracket.
ANNUITY TRUST IRA RATE INCOME REMAINDER TAX 3.2% $730,000 $270,000 $108,000 6.0% $573,500 $426,500 $170,600 8.0% $490,905 $509,095 $203,638 12.0% $373,470 $625,530 $250,612
UNITRUST IRS RATE INCOME REMAINDER TAX 3.2% $629,579 $370,421 $148,168 6.0% $619,463 $380,537 $152,215 8.0% $612,491 $387,509 $155,004 12.0 $598,746 $401,254 $160,502

As is clear, the lower the IRS discount rate, the lower the amount of remainder transfer subject to tax. While this is true for the annuity trust and the unitrust, the effect, as noted in the boxed example above, is much more dramatic with the annuity trust. The difference in remainder values for the annuity trust, for discount rates of 3.2 percent and 8 percent, is almost $240,000—nearly double. This shows how important the discount rate is in a charitable lead annuity trust. The difference between two lead unitrusts using 3.2 percent and 8 percent discount rates is far less, only a little more than $17,000.

Frozen at Transfer
Paying any tax at all may seem like a stiff penalty for being charitable, but because the asset's value is frozen at the moment it is transferred to the trust—at which time the tax is calculated—the potential benefit is real, and can be substantial.

Any growth in the trust's value by the time the asset is transferred to the noncharitable remainderman will go untaxed. This can also represent quite a benefit.

If the annuity trust grows to $2 million over the years, after the annual $50,000 payments to the charitable organization, the donor (should he or she still be alive) or the donor's estate (should he or she be deceased) will not pay any taxes on the transfer.

If applying a 40 percent transfer tax, the tax at that time would be $800,000. This is far more than the $108,000 tax paid at the time the trust is established.

If the $800,000 is discounted 5 percent per year, to take inflation or declining purchasing power into account over the 20-year period, then the resulting number would be about $301,000, still about two and one-half times the tax that would be due today.

There is no question that a lead trust generates the potential to make a sizable gift to a charitable organization at relatively little cost to heirs.

As for the growth outside a lead trust, it is true that assets without a payout obligation will grow faster. The assets in this case, if they were to grow at 7 percent per year for 20 years, would be valued at almost $4 million at the end of that time. This means the transfer tax, at the 40 percent rate, would be approximately $1.6 million, leaving the heirs $2.4 million after taxes The difference in the actual amount transferred to heirs is $500,000, but then we must subtract the tax difference as well, which, even at an inflation-adjusted value, is still more than $200,000.

But, as can be seen, far less tax is paid to the government and far more money is donated to the charitable organization. Over 20 years, the charitable organization receives $1 million.

Planned for Growth
A common goal of donors and practitioners is to get the value of the remainder amount to as low a number as possible while still planning for growth within the trust. While it is possible to generate a low number in other economic environments, a higher discount rate forces the donor to lengthen the number of years or agree to pay more to the charitable organization each year. Both actions have the effect of providing less for the noncharitable remaindermen.

One reason the nongrantor trust is more popular than the grantor trust is that the donor pays the tax on any income or realized gain in the grantor trust. The donor of a grantor trust, however, is able to take an income tax deduction for the income value deemed to pass to the charitable organization over the trust's term, a benefit not permitted to the nongrantor trust donor.

The main reason, however, for the popularity of the nongrantor lead trust is that it has more powerful estate planning potential than the grantor trust.

Unlike remainder trusts, lead trusts can pay less than remainder trusts and go for a longer period, as long as they do not conflict with state laws prohibiting trusts from existing in perpetuity.

Also, charitable distributions from a lead trust are not subject to the normal ceiling limitations. That is, the 30 percent and 50 percent limitations each year on what a donor may deduct for charitable contributions do not apply to distributions from a nongrantor lead trust. Although the donor does not get an income tax deduction for a contribution to a nongrantor lead trust, the donor is also not taxed on the income, resulting in a wash. It is as if the donor received all of the income and was able to give it away to a charitable organization without worrying about percentage limitations. Therefore, this is a good strategy for donors with percentage limitation problems.

Asset Management
The most common asset used to fund a lead trust is closely held stock in a family business that has the potential to grow over the years. Many times, the donor does not want the asset sold. Unlike in a charitable remainder trust, where the assets are almost always immediately sold because there is no capital gains tax, a lead trust typically holds on to the donated assets.

If the lead interest exceeds 60 percent of the value of the trust, the excess business holdings rules apply and require the stock to be disposed of by the trust within five years.

Not selling the asset is quite common. This is because many donors not only want to later transfer value to their heirs, they also want to transfer a specific asset. To do this, the stock must generate a dividend so that income can be distributed to a charitable organization, or the asset must be liquid enough so that a portion of it can be sold to make a payment to the charitable organization. Any gain realized while satisfying the payment requirement is deductible from the trust. Also, it is possible to satisfy the payment obligation with the stock itself. In that case, the charitable organization usually sells the stock back to the company, which then retires it. In any event, the best funding asset for a charitable lead trust is one that is expected to appreciate in value over the years.

Whatever the asset, though, if it is not sold during the term of the trust, the asset maintains its original cost basis when it is distributed to the noncharitable remaindermen. For example, say a lead trust is funded with an asset valued at $1 million; it grows to $2 million by the trust term's end, but it had a zero cost basis. If the heirs wanted to sell the asset, they would pay a capital gains tax on the entire $2 million.

Please call The Office of Gift Planning at 507-457-6647, or e-mail us at giving@smumn.edu, for more information.

About the Author: Doug White
Douglas White consults with nonprofits on various aspects of philanthropy. He has served in leading roles with planned gift investment firms, as the development director at a secondary school and as trustee at several charitable organizations.

Doug is the author of the award-winning book The Art of Planned Giving: Understanding Donors and the Culture of Giving (John Wiley and Sons, 1995). In addition, he has written many articles.

He is a past member of the board of directors of the National Committee on Planned Giving. During his tenure at NCPG he founded the national initiative of "Leave A Legacy." He is a past president of the Planned Giving Group of New England and past president of the New Hampshire/ Vermont chapter of AFP.

For more than a decade he has served as the national capital giving chair for Phillips Exeter Academy in Exeter, N.H. In 2002, the National Capital Gift Planning Council presented Doug with the "Distinguished Service Award."

Doug is located in Washington, D.C.

Maximize Memorials for a Lasting Influence

By Katelyn Quynn

Charitable organizations are quick to recognize that some of their greatest donors are those who want to make memorial gifts in honor of a loved one. Professional planning advisors often play a key role in helping make that happen.

Many future donors who are financially able, and philanthropically inspired, want to see something good come from a tragic event. Completing a gift often helps the donor through the grieving process.

Donors may want to give to a charitable endeavor to remember a wife or mother who lost her battle with breast cancer, a loving friend who died in a tragic automobile accident, or a son or daughter killed during military action. Individuals who want to make memorial gifts in honor of a loved one represent some of an organization's greatest potential donors.

Defining a Memorial Gift
A memorial gift is a gift made at an individual's death, that benefits a charitable organization preselected by the deceased or the deceased's family or friends. "In lieu of flowers, donations can be made to the Specified Organization," is a memorial designation often seen in an obituary. This type of memorial giving results in small gifts—often $25 to $100 gifts—that are received by the named organization for a short time following the individual's death. Sadly, after acknowledgement by the charitable organization and the family, the relationship often ends.

Less common, but still often seen at many nonprofit organizations, are gifts created at a loved one's death by a loving spouse, parent, child, other family members, friends or groups of grieving individuals, like co-workers.

These gifts are larger gifts ($25,000 to $1 million or more) that take many forms and require patience, expertise and savvy by the organization and any affiliated professional advisors involved in the process.

Donors who make these larger memorial gifts often, but not always, approach the charitable organization on their own and have a very specific idea about how they wish to make their gift. The resulting gift, after discussion with advisors, may or may not be what donors initially envisioned.

What Else Motivates the Donor to Give?
Besides wanting to honor the deceased, a donor can be motivated by other reasons to make a substantial memorial gift to a charitable organization.

It is helpful to determine what else, if anything, a donor may hope to accomplish by making this gift. Uncovering additional motivations helps affiliated advisors determine the real potential size of the gift, how the gift should be made, and how best to cultivate the donor and celebrate the gift.

The following types of donor motivations should be considered when working with a substantial memorial gift donor:

• Purely Philanthropic. The gift is being made by a donor who purely wants to remember the deceased and may want to make the gift anonymously. A rare type of donor, this person acts selflessly and from the heart. Allied professionals involved in developing the gift need to listen closely and follow the donor's wishes regarding the gift. This type of donor already knows exactly how the gift should be implemented to meet family wishes.
• Family Substitute. The donor is alone in the world, perhaps as the childless spouse of the deceased. This person will likely appreciate interaction with the charitable organization, during the grieving process and beyond, as part of an extended family.
• Social Standing/Prestige. The donor hopes to gain some prestige, either with one individual or a group of people, by making the gift. The donor may enjoy some media coverage for the gift and a celebration that will allow the donor to be recognized.
• Assurance Policy. If a donor seems motivated by the expectation, then he or she will be assured of special consideration by the receiving organization. It is an advisor's role to review any ground rules that apply to VIP treatment, especially if preferential treatment might jeopardize some of the tax benefits.

Dealing with Emotions Associated with Loss

• Sadness
  Professional giving advisors who deal with individuals and families making meaningful memorial gifts are likely to encounter a potential range of emotion and should be prepared to show empathy. Sadness and grief are the most common emotions. If the advisor has personally experienced a loss, he or she can build rapport by sharing his or her personal experiences.
  
  
• Anger
  Some donors will want to share their anger with their advisor—anger over the loss of a loved one or about the medical care or lack thereof received by the deceased, especially if the charitable organization is a hospital. The best way to manage this type of emotion is to act as a sounding board and then refocus the donor on the positive, reminding him or her of the good the gift will do and how it will help future patients.
  
  
• Confusion/Uncertainty
  During a time of mourning, individuals often struggle to adjust to their new situation—life without their loved one. Depending upon age, health and relationship to the deceased, some individuals deal with this better than others. It may be difficult for the donor to concentrate on the gift options, especially if not much time has passed since the death.

Many professional advisors find that the gift option the donor initially wanted is not the gift option that is finalized. This seems to be especially true for naming opportunities. In the beginning, family members sometimes shy away from having something named after the deceased. They may feel embarrassed about this idea or might be unwilling to share their grief in public. Over time, however, a naming opportunity can be the perfect way to create a lasting tribute to the deceased, and many locations at charitable organizations bear the names of loved ones memorialized by friends and family.

Working With Family Members
In addition to working with a range of emotions, memorial gifts often include working with more than one family member throughout the gift process. This presents an interesting challenge for the most experienced advisors. They often have to handle multiple personalities, emotions and ideas for the gift, including type of gift and its ultimate amount.

Try to include all relevant family members, but first, and very importantly, determine which individual is the true decision maker. Work closely with that individual to narrow the giving decision. Listen as family members express their own remembrance of the deceased and any symbolism that might be shown through the chosen gift.

Fortunately, a significant memorial gift can allow participation from many family members at different financial levels. If the gift is an outright naming opportunity, all family members can give at various amounts and with different assets such as cash, securities or mutual funds. Each family member can take a charitable income tax deduction based on the size of his or her gift, and all have the opportunity to be involved and celebrate the memory of the deceased.

Types of Gifts
A memorial gift takes many forms and is as varied as each donor who makes the gift. Ultimately, the charitable organization wants to make the donor feel good about the gift and how the deceased is honored. The following are a few examples of typical memorial gifts

• Naming Opportunities
  Many donors like to honor a loved one by placing the deceased's name on a plaque in a location that will memorialize him or her in a permanent, public way. It is not atypical to name a building, center, wing, floor, elevator, waiting room, patient room, classroom or other space. Naming a building, wing or floor is usually the highest-value gift option at most charitable organizations, and the actual level varies with each organization. With such a permanent remembrance, the donor and family can revisit the location and witness the good the gift has done
• Chair or Professorship
  At academic institutions, a chair or professorship is often one of the highest honors and levels of gift options, usually in the $2 million to $3 million range. Donors who make significant memorial gifts can name a professorship and have it benefit a department or area connected to the deceased. For example, if the deceased was a classics professor, a chair could be created in the classics department, focusing on a particular area of study. Or, if the deceased respected a physician in the hospital's cancer center, a chair could be created in the cancer department, named for the deceased and held by the physician being honored for the benefit of his or her area of research.
• Endowed Funds
  Endowed funds are wonderful gift options to suggest to a donor who is interested in creating a memorial gift. An endowed fund can be created for various amounts depending on the organization (e.g., $10,000, $25,000, etc.), can be named for the deceased and continues in perpetuity. It can benefit any area at the charitable organization and typically pays about 5 percent of the principal amount in the fund to the recipient. Once the fund is created, family members and friends can add to it at any time and may want to build the fund by making an additional gift on the anniversary of the deceased's death or in lieu of holiday presents or other significant dates in the family. Endowed funds help keep a memory alive and can keep a family together over time.
• Other Options
  The development officer should offer a variety of gift options to the donor and work with him or her to find an option that accomplishes the donor's wishes in a tax-efficient manner.
  
  The gift can take the form of an outright gift of cash, securities or mutual funds. Or it may be a life income gift such as a charitable gift annuity, deferred gift annuity or charitable remainder trust. Other gestures could include a bequest in the donor's will, a private foundation named in memory of the deceased that makes gifts to a favorite charitable organization of the deceased, a supporting organization that benefits select charities or a donor advised fund t